Entrepreneurial activity, risk, andthe business cycle$

This paper analyzes a model in which the risk associated with entrepreneurial activity implies that the amount of such activity is procyclical andresults in amplification and intertemporal propagation of productivity shocks. In the model risk averse agents choose between a riskless project anda risky project with higher expectedoutput (‘the entrepreneurial activity’). Agents who become entrepreneurs needto bear part of the project-specific risk for incentive reasons. More agents become entrepreneurs when productivity is high, because agents are more willing to bear risk andneed to bear less risk for incentive reasons. Furthermore, cross-sectional heterogeneity can be countercyclical. r 2003 Elsevier B.V. All rights reserved.